Exchange-Traded Funds For Dummies (2024)

FAQs

What is an exchange-traded fund for dummies? ›

ETF meaning

An exchange-traded fund (ETF) is a basket of investments like stocks or bonds. Exchange-traded funds let you invest in many securities all at once, and ETFs often have lower fees than other types of funds.

ETFs or "exchange-traded funds" are exactly as the name implies: funds that trade on exchanges, generally tracking a specific index. When you invest in an ETF, you get a bundle of assets you can buy and sell during market hours—potentially lowering your risk and exposure, while helping to diversify your portfolio.

ETFs are funds that issue shares, which are traded on a stock exchange. ETFs cover a broad range of asset classes and can give exposure to specific markets, sectors or investment strategies. Many ETFs track an index in order to provide this return.

Before purchasing an ETF there are five factors to take into account 1) performance of the ETF 2) the underlying index of the ETF 3) the ETF's structure 4) when and how to trade the ETF and 5) the total cost of the ETF.

Most ETF income is generated by the fund's underlying holdings. Typically, that means dividends from stocks or interest (coupons) from bonds. Dividends: These are a portion of the company's earnings paid out in cash or shares to stockholders on a per-share basis, sometimes to attract investors to buy the stock.

Though ETFs can lose money, they are still considered less risky than stocks. That's because instead of holding a few individual stocks, an ETF can hold hundreds or even thousands.

SPDR Gold Trust (GLD), iShares Silver Trust (SLV), and United States Oil ETF (USO) are examples of commodity ETFs.

Stocks involve physical ownership of the security. ETFs diversify risk by creating a portfolio that can span multiple asset classes, sectors, industries, and security instruments. Mutual funds diversify risk by creating a portfolio that can span multiple asset classes, sectors, industries, and security instruments.

You expose your portfolio to much higher risk with sector ETFs, so you should use them sparingly, but investing 5% to 10% of your total portfolio assets may be appropriate. If you want to be highly conservative, don't use these at all. Consider the two funds below.

What are the pros and cons of exchange funds? ›

Are Exchange Funds a good idea? Yes, exchange funds is a good option for investors with concentrated stock holdings looking to diversify their portfolios while deferring taxes. They come with some disadvantages, such as deferred tax liability, fees, complexity, limited availability, and less control over investments.

Key Takeaways

Introduced in the U.S. in 1993, ETFs have become one of the most popular investment choices for investors. ETFs may close due to lack of investor interest or poor returns. For investors, the easiest way to exit an ETF investment is to sell it on the open market.

The majority of individual investors should, however, seek to hold 5 to 10 ETFs that are diverse in terms of asset classes, regions, and other factors. Investors can diversify their investment portfolio across several industries and asset classes while maintaining simplicity by buying 5 to 10 ETFs.

Indexed ETFs, tracking specific indexes like the S&P 500, are generally safe and tend to gain value over time. Leveraged ETFs can be used to amplify returns, but they can be riskier due to increased volatility.

ETFs tend to be less volatile than individual stocks, meaning your investment won't swing in value as much. The best ETFs have low expense ratios, the fund's cost as a percentage of your investment. The best may charge only a few dollars annually for every $10,000 invested.

With a mutual fund, you buy and sell based on dollars, not market price or shares. And you can specify any dollar amount you want—down to the penny or as a nice round figure, like $3,000. With an ETF, you buy and sell based on market price—and you can only trade full shares.

When you invest in an ETF, you don't own the underlying investments. You own units in the ETF and the ETF provider owns the shares or assets.

An exchange fund, also known as a swap fund, is a private investment fund designed for long-term investors with concentrated stock positions to diversify their portfolio and reduce taxes.